Australia’s biggest international fund manager believes Treasurer Joe Hockey should be taking the possibility of a housing bubble more seriously and worries money-printing by central banks is creating asset bubbles.

Matthew McLennan, who manages $80 billion of assets in New York for First Eagle Investment Management, revealed to AFR Weekend he won’t invest in Australian banks because they are too risky and is concerned about the levels of private sector debt in Australia.

The publicity-shy Mr McLennan, 44, was selected to run the privately held fund manager’s global equities funds in 2008 after 14 years as a fund manager at Goldman Sachs in Sydney, New York and London.

His Global Value Fund has returned 14.7 per cent annually after fees since its inception in 1979, almost 5 per cent each year above the relevant MSCI World Value Index.

While First Eagle Investment Management and Mr McLennan are virtually unknown in Australia, the company has a storied history on Wall Street. Hedge fund maven George Soros and his partner Jim Rogers were employees early in their careers.

Mr McLennan studied at Brisbane Grammar School and the University of Queensland, worked briefly at the QIC and was appointed a managing director at Goldman Sachs at the age of 33.

Mr McLennan, whose father worked as a land surveyor, responded that he could not fathom “why people felt the need to say a market is not in a ­bubble" given the high relative property prices.

“I don’t think that’s a prudent approach when you see large levels of leverage and fairly low rental yields," he said. “I don’t know what the upside is in talking down legitimate risks."

Mr McLennan said he thought ­Australian house prices were “on the full side of fair value in a situation where the marginal buyer is already quite levered". Australia’s house price-to-income ratio is less than 10 per cent below its all-time peak.

Not keen on Australian banks

In a reference to the federal government’s position view on rising prices, Mr McLennan said investors felt “far more confident when a management team tells you what it is worried about than when it displays ­complacency".

Asked if he had invested in Australian banks, which are highly profitable by overseas standards, Mr McLennan said he was put off by the major banks’ lofty leverage, which averages 27 times their underlying equity capital, and their exposure to fickle wholesale bond markets.

“We haven’t been investors in the Aussie major banks, because the raw equity-to-asset ratios . . . are lower than our comfort zone," he said.

While the banks have profited from a “fair amount of cumulative credit growth over the last generation" Mr McLennan said their “reserves-to-loan losses" appeared to be “pretty low in the scheme of things".

He warned the Australian economy, which was dubbed by The Economist magazine as the “wonder Down Under" for 22 years of uninterrupted growth, may soon start to struggle.

“I have a few question marks over the Australian economy and think the ­outlook could be potentially quite challenging," he said.

He said Australia’s low government debt-to-GDP ratio – long a point of pride for the previous Labor government – was a function of “a lot of excess debt in the private sector".

Challenging economic outlook

“If you had a crisis in the private ­sector, the sovereign finances would ­deteriorate quickly," he said. Mr McLennan added his concerns centred on two areas. China is shifting from an export-based economy that had powered Australia’s boom in iron ore, coal and gas investment to greater domestic consumption.

“This is happening at a time when you are seeing material weakness in the Indonesian, Japanese and Indian ­currencies, which means that “competitive pressures are ramping up on China," he said.

“Currency instability in some of ­Australia’s largest neighbours . . . could portend a more difficult period ahead for both us and Asia."

The second challenge is Australia’s “internal shift from structural tail-winds to structural headwinds".

“Notwithstanding the mining boom, several decades of pretty large current account deficits in Australia have ­produced a very highly leveraged ­private sector," he said.

“If we have the private sector in balance-sheet repair mode at a time when the government goes into fiscal restraint, this could give us a fairly soft underlying pulse, ­especially if China is chugging along more slowly."

QE and rate cuts is ‘financial repression’

The fund manager attacked “financial repression" by central banks which had cut real interest rates to record lows, and the policy known as “quantitative easing" whereby they print money to buy government debt, corporate bonds and shares, to bid up their prices above natural market levels and reduce the implied cost of capital.

“The problem with that mental model is that it assumes you are starting from a point of view of asset prices being below their equilibrium values and savings being excessive," he said.

“So you are seeking to stimulate new investment, dissuade savings, and get asset prices back to their normal values. But if asset prices are already at ­reasonably elevated levels relative to long-term history, and savings are close to generational lows, it is not clear to me that repressing interest rates and engaging in quantitative easing is prudent policy."

Mr McLennan said he thought an end game would arrive if people “start to realise that the quality of money has become impaired".

“If we blow another bubble now that bursts, and the sovereign is forced to step in again with its higher level of starting debt, at a certain point the system has to become unsustainable," he said.

“You either have to print more money or accept deflation. My fear is that the risk in the current global financial system is that you get one of these extreme corner solutions."